Interesting question, and let's briefly start with a conventional definition of Total Return Swap (assuming the reference asset is a stock index). As a matter of fact a TRS is an agreement to exchange the total return (dividends + capital gains) realized on a stock index for either a fixed or a floating rate of interest (e.g LIBOR, LIBBOR + spread (in basis points)) as very-well summarized in your picture.
Both exchange of cash flows between the Fixed-leg Payer and the Floating-leg Payer being applied on the swap notional amount.
*For concreteness purposes, it's worth adding an additional stakeholder (Broker), thus the parties in a TRS generally involve:
1- Hedge Fund_1 (as requested)
2- Hedge Fund_2 (idem)
3- Prime Broker , holding the reference asset (e.g proprietary index, etc.) and also generally acting as a Counterparty of the trade.
**In an attempt to avoid any Informational Asymmetry, Moral Hazard, etc., the Broker (e.g Custodian Bank) is performing the computations (compute Index levels, Returns, at
time t, mostly for proprietary indexes) and disclose it (on its website or on request) for transparency purposes while valuing the swap (Mark-To-Market) in accordance with the terms of the contract/agreement stipulated in the Swap Term Sheet. For instance it could be stated in the Term Sheet that
Hedge Fund_1 pays 15 basis points or LIBOR + 10 bp to
Hedge Fund_2 if:
Index level is > a defined threshlod (yesetrday's value),
Otherwise receive from
Hedge Fund_2 the return at
t on the index.
The latter document could be obtained on request from the
Counterparty of the trade, if neither
Hedge Fund_1 nor
Hedge Fund_2 has their own copy internally. It's worth stating that these agreements have legal implications, thus are generally signed by all the parties.
Ps: Mark-to-Mark value of the swap is also disclosed in the Net Asset Value (NAV) file sent frequently by the Fund Administrator to the Hedge Fund Managers (
Hedge Fund_1 or
**In the case of Credit Derivatives, the Reference Asset is usually
iTraxx, but the above logic applies as well.
Hope it helps